New Economics Papers
on Risk Management
Issue of 2010‒02‒20
seven papers chosen by

  1. Risk Management and Managerial Efficiency in Chinese Banks: A Network DEA Framework By Matthews, Kent
  2. The impact of capital and disclosure requirements on risks and risk taking incentives By Ojo, Marianne
  3. Integrating Operational and Financial Risk Assessments By Silvia Figini; Ron Kenett; SILVIA SALINI
  4. Modern Risk Management Strategies for the Romanian State Treasury By Cosma, Dorin; Cosma, Octavian
  5. Stress testing and contingency funding plans: an analysis of current practices in the Luxembourg banking sector By Franco Stragiotti
  6. A new space-time model for volatility clustering in the financial market By Maria Boguta; Eric J\"arpe
  7. Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH By Tansuchat, R.; Chang, C-L.; McAleer, M.J.

  1. By: Matthews, Kent (Cardiff Business School)
    Abstract: Risk Management in Chinese banks has traditionally been the Cinderella of its internal functions. Political stricture and developmental imperative have often overridden standard practice of risk management resulting in large non-performing loan (NPL) ratios. One of the stated aims of opening up the Chinese banks to foreign strategic investment is the development of risk management functions. In recent years NPL ratios have declined through a mixture of recovery, asset management operation and expanded balance sheets. However, the training and practice of risk managers remain second class compared with foreign banks operating in China. This paper evaluates bank performance using a Network DEA approach where an index of risk management practice and an index of risk management organisation are used as intermediate inputs in the production process. The two indices are constructed from a survey of risk managers in domestic banks and foreign banks operating in China. The use of network DEA aids the manager in identifying the stages of production that need attention.
    Keywords: Risk management; risk organisation; managerial efficiency; Network DEA
    JEL: D23 G21 G28
    Date: 2010–02
  2. By: Ojo, Marianne
    Abstract: This paper is primarily aimed at highlighting the role and significance of asymmetric information in contributing to financial contagion. Furthermore, in emphasising the importance of greater disclosure requirements and the need for the disclosure of information relating to “close links”, such disclosure being considered vital in assisting the regulator in identifying potential sources of material risks, it illustrates the fact that incentives (such as the reduction in the levels of capital to be retained by institutions), which have the potential to facilitate market based regulation (through non binding regulations), may not necessarily serve as suitable means in the realisation of some of Basel II’s objectives – namely the achievement of “prudentially sound, incentive-compatible and risk sensitive capital requirements”. The paper also attempts to raise the awareness that the operation of risk mitigants does not justify a reduction in the capital levels to be retained by banks – since banks operating with risk mitigants could still be considered inefficient operators of their management information systems (MIS), internal control systems, and risk management processes. The fact that banks possess risk mitigants does not necessarily imply that they are complying with Basel Core Principles for effective supervision (particularly Core Principles 7 and 17) – as the paper will seek to demonstrate. Core Principle 7 not only stipulates that “banks and banking groups satisfy supervisory requirements of a comprehensive management process, ensure that this identifies, evaluates, monitors and controls or mitigates all material risks and assesses their overall capital adequacy in relation to their risk profile, but that such processes correspond to the size and complexity of the institution.” Certain incentives which assume the form of capital reductions are considered by the Basel Committee to “impose minimum operational standards in recognition that poor management of operational risks (including legal risks) could render such risk mitigants of effectively little or no value and that although partial mitigation is rewarded, banks will be required to hold capital against residual risks”. Information disclosure should be encouraged for several reasons, amongst which include the fact that imperfect information is considered to be a cause of market failure – which “reduces the maximisation potential of regulatory competition”, and also because disclosure requirements would contribute to the reduction of risks which could be generated when granting reduced capital level rewards to banks who may have poor management systems.
    Keywords: incentives; risk; mitigants; Basel; regulation; regulatory competition; disclosure
    JEL: D53 K2 F3 E5 D82
    Date: 2010–02
  3. By: Silvia Figini (University of Pavia); Ron Kenett (KPA Ltd.); SILVIA SALINI (Department of Economics, Business and Statistics - Universiy of Milan)
    Abstract: This paper proposes a novel methodology for integrating nan- cial risk and operational risk. In order to demonstrate the approach, we use real data from a telecommunication company providing services to enterprises in dierent business lines and geographical locations. For each enterprise, we have collected information about operational and nancial performance. Our objective is to produce a coherent measure of risk, integrating operational losses from various types of equipment failures and nancial risks derived from balance sheet information. The approach demonstrated in this case study can be generalized to general service providers who need to account for both the quality of service and the nancial solvency of their customers. Adressing risks in both dimensions is critical to long term sustainability and business continuity.
    Keywords: Non Linear Principal Component Analysis, Score models, Bayesian integration, Basel Committee, operational risks, financial risks,
    Date: 2010–01–26
  4. By: Cosma, Dorin; Cosma, Octavian
    Abstract: This paper is exploring the introduction and modernization of corporative governance in public institutions, specifically in the Romanian State Treasury, by standardizing the risk evaluation in audit (RBIA). The authors are considering that achieving results in the country's progress is impossible by only implementing imported external solutions - for optimal results adjustments to internal and external historical characteristics and local interests are required. This requirement is reinforced by analyzing the economical devlopments that have taken place during the last 20 years (since migrating the economy from a centralized state to free markets), which also supports the authors' premise that further significant development is possible if the proper methods are put in place.
    Keywords: governance; risk; evaluation; management; audit; analysis
    JEL: C10 D81 B40 G38 H83 G32
    Date: 2009–11–10
  5. By: Franco Stragiotti
    Abstract: This paper analyzes the current practices adopted by a sample of Luxembourg banks on liquidity stress testing and contingency funding plans. The paper covers four main topics: liquidity stress testing coverage, scenario design, policy issues and contingency funding plans. We compare, when relevant, these results to a larger sample of EU peer banks. The results, collected through a questionnaire addressed to forty-seven banking groups, are analyzed by the means of the principal component technique. The paper also highlights the main features and shortcomings of local banks in this field.
    Keywords: liquidity risk, liquidity stress testing, contingency funding plan, principal component analysis.
    JEL: G21
    Date: 2009–12
  6. By: Maria Boguta; Eric J\"arpe
    Abstract: A new space-time model for interacting agents on the financial market is presented. It is a combination of the Curie-Weiss model and a space-time model introduced by J\"arpe 2005. Properties of the model are derived with focus on the critical temperature and magnetization. It turns out that the Hamiltonian is a sufficient statistic for the temperature parameter and thus statistical inference about this parameter can be performed. Thus e.g. statements about how far the current financial situation is from a financial crisis can be made, and financial trading stability be monitored for detection of malicious risk indicating signals.
    Date: 2010–02
  7. By: Tansuchat, R.; Chang, C-L.; McAleer, M.J. (Erasmus Econometric Institute)
    Abstract: The paper examines the performance of four multivariate volatility models, namely CCC, VARMA-GARCH, DCC and BEKK, for the crude oil spot and futures returns of two major benchmark international crude oil markets, Brent and WTI, to calculate optimal portfolio weights and optimal hedge ratios, and to suggest a crude oil hedge strategy. The empirical results show that the optimal portfolio weights of all multivariate volatility models for Brent suggest holding futures in larger proportions than spot. For WTI, however, DCC and BEKK suggest holding crude oil futures to spot, but CCC and VARMA-GARCH suggest holding crude oil spot to futures. In addition, the calculated optimal hedge ratios (OHRs) from each multivariate conditional volatility model give the time-varying hedge ratios, and recommend to short in crude oil futures with a high proportion of one dollar long in crude oil spot. Finally, the hedging effectiveness indicates that DCC (BEKK) is the best (worst) model for OHR calculation in terms of reducing the variance of the portfolio.
    Keywords: multivariate GARCH;conditional correlations;crude oil prices;optimal hedge ratio;optimal portfolio weights;hedging strategies
    Date: 2010–02–08

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